I am trying to to make a multiclip with two HD 1080 videos and a SD video. Is this just not possible? Should I recapture my HD footage and downconvert or export as SD video? Any thoughts would be greatly appreciated.

I have used multiclip for over a year and have never had this error message.

I got the same message today, using three HDV clips captured the exact same way. Curiously, I just downloaded the update for FCS2. I cannot find anything about this online, though in your case I've never tried SD w/ FCP.